MAKING CENTS: A counterintuitive plan for retired high earners

Tuesday

Most Americans are conditioned to postpone the payment of income taxes for as long as humanly possible. Yet for some, this desire could end up costing more in the long run.

I’m specifically thinking about those who were high earners during their working years. During the first few years of retirement, before your required minimum distributions (RMD’s) kick in, you may feel pretty good about filing tax returns with a very low taxable income and an equally low amount of tax. But that temporary joy could be even better if you extended your tax planning mentality to all of your retirement years, not just the first few.

Because of the new tax act, taxable income over about $9,500 will be taxed at 12 percent. That’s a pretty low rate for someone who may be used to paying in excess of 30 percent in federal taxes.

That 12 percent tax bracket for married couples filing jointly lasts until your taxable income creeps over $77,400. If you’re likely to be over that amount when you must start taking retirement distributions, this year could be a year when you may consider creating income, but at a lower tax rate. For a retiree, the best way to create income is to withdraw money from retirement assets.

Creating income from retirement withdrawals that bring you to the brink of the next bracket, which is 22 percent, may be one of your last opportunities to pay income taxes at the 12 percent rate.

If you don’t want the income because you have other non-retirement assets from which to draw, consider making a Roth IRA conversion with some of the retirement assets. The amount converted will be taxed at this year at 12 percent and you’ll now own an IRA that will never be taxed again either to you or your beneficiaries.

This is a very powerful intergenerational planning tool, especially for grandchildren. It’s important to note that Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional to a Roth IRA. The converted amount is generally subject to income taxation.

Another consideration is to use this low bracket year to diversify your portfolio. Commonly we see retirees with a few investment positions that they’ve held for years with a very low tax basis. If your taxable income stays under that famous $77,400 amount, your capital gains tax will be $0 for federal tax purposes. Elder taxpayers who have often owned certain blue chip stocks for decades frequently aren’t aware of this tax free way of selling investments.

This is tax planning with precision. In order to benefit most from this type of planning, there are two critical factors. First is that you must act on good information. Get an accurate forecast of your income and tax bracket before the year comes to a close. The second is timeliness. While these strategies can have a profound affect over the long term, there is short term action needed. All of these moves must happen before the year ends.

These opportunities will exist in future years as long as your income stays low. Even a little tweaking each year will add up to a lot over the long term.